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Wednesday, October 29, 2014

There's been nothing like the death of Gough Whitlam to make me feel
old. Was I on the job in the early 1970s watching the amazing scenes and
taking note? Sure. Where was I when the Great Man was dismissed? In the
building, where else? Later that night I was in a Canberra restaurant
where Tom Uren wept from table to table.

But there's nothing to make
me feel more disillusioned and cynical than the latest prime minister
popping up to tell us his grand plans to revitalise federal-state
relations. Really? That's what they all try. What makes Tony Abbott
likely to succeed where his many predecessors - going right back to
Whitlam - failed so dismally?

Since Abbott's plan raises the
possibility of tax reforms - "including changes to the indirect tax
base" - he'll be lucky if the "mature debate" and "rational discussion
about who does what" he seeks doesn't erupt immediately into an
Abbott-strength scare campaign about increasing the goods and services
tax, led by a Labor Party with a long record of hypocrisy on the topic
and a thirst for revenge.

In such a climate, the various premiers
facing re-election in coming months are likely to swear total opposition
to any change in the GST. These days our politicians excel in the
Mexican standoff.

Whitlam was seen as the great centraliser,
drawing furious attack from the premiers and a Coalition sworn to uphold
"states' rights". But subsequent thought has been kind to his notion
that the ideal model would be a strong central government dealing with
many regional governments, closer to the ground than the present state
governments and given flexibility to modify national rules to suit local
conditions.

Forty years later it's obvious that ain't going to
happen. However anachronistic, the state governments - within their own
borders, just as centralist as any federal government - won't ever give
up their rights and privileges.

Malcolm Fraser's "new federalism"
involved making the states more self-sufficient by giving each the right
to impose their own surcharge or discount on federal income tax. The
premiers, always full of complaints about the inadequate money they're
given, weren't the least bit attracted to new taxing powers.

The
Hawke-Keating government continued the process of ever-increasing
federal involvement in areas of state responsibility. It pioneered the
practice of bribing the premiers to undertake desired reforms.

John
Howard did little to conceal his centralist tendencies, dropping any
pretence of favouring states' rights. More and more "specific-purpose
payments" to the states came with detailed rules about how the money was
to be spent.

Part of his reason for introducing a GST was the
need to replace the revenue from various state taxes the High Court had
ruled unconstitutional. His decision to give all the proceeds from the
new tax to the states (and cut back other grants to fit) was an inspired
move to neutralise the premiers' opposition to it.

His greatest
act of centralisation came with Work Choices, which ended a century of
(highly inefficient) shared federal-state responsibility for industrial
relations.

Kevin Rudd tried to improve federal-state relations by
greatly rationalising the thousands of conditions attached to federal
grants. His efforts to reach federal-state agreement on removing
regulatory inconsistencies ground to a halt as states dragged their
heels. He lacked the resolve to carry out his threat of a full federal
takeover of state public hospitals.

Now Abbott says he wants to
reverse the creeping centralisation, reaching a rational division of
roles that would make each level of government "sovereign in its own
sphere". As part of this, he'd support a joint plan to increase
collections from the (withering) GST and give all the proceeds to the
states, taking it to the next federal election for voters' approval.

Trouble
is, there's no suggestion this would leave the premiers with more money
overall and, if this year's budget is any indication, no guarantee the
feds wouldn't try to solve their own budget problems at the states'
expense.

It's unlikely federal and state governments could ever
reach a lasting division of responsibilities that would end the
duplication, cost-shifting and blame-shifting. That's for a host of
reasons.

Most of the economic arguments favour nationally uniform
regulations. If the feds are to retain ultimate responsibility for the
health of the economy, they need the ability to influence the building
blocks of economic performance, such as schools and TAFE.

Federal
Medicare and pharmaceutical benefits, and state public hospitals, are
each parts of the same system, which must be co-ordinated.

The
underlying problem of "vertical fiscal imbalance" - most tax revenue
(including the GST) is raised by the feds, whereas most government
spending is done by the states - is intractable, the product of history
and constitutional law.

When the feds cop most of the opprobrium
for extracting taxation, it's only human for them to want a say in how
it's spent.

But when the premiers get used to spending lots of money
without having to raise it, to demanding more from the miserly feds on
behalf of their deserving constituents and to blaming any and all
problems on those terrible incompetents in Canberra, it's only human for
them to want to continue evading responsibility.

The premiers'
"revealed preference", as economists say, is that they prefer the
federal system as it is, including their right to complain bitterly
about it and demand another handout.

Monday, October 27, 2014

As every small-business person knows, the econocrats who think they
manage the economy sit in their offices without ever meeting real
people. Instead, they pore over figures the Bureau of Statistics bods
dream up without ever leaving their desks.

That last bit has always
been wrong. Small business is run by people who think their sales this
week equal the state of the national economy. If the official figures
don't line up with their experience, some bureaucrat must be lying.

The
first bit - that the macro managers look at stats without ever talking
to business people - used to be true, but hasn't been since some time
after the severe recession of the early 1990s.

That was when
Treasury (and yours truly) was supremely confident the economy would
have a "soft landing". For once, people who knew no economics but had
heard the squeals coming from business were right and the supposed
experts were wrong.

The econocrats' disdain for "anecdotal
evidence" had led them badly astray. They learnt the obvious lesson: as
well as studying the stats, they needed to keep their ears to the
ground.

But what even many well-versed observers probably don't
realise is just how much effort the Reserve Bank puts into its
consultations with business and how seriously it takes the results. The
workings of its "business liaison program" are described in an article
in the Reserve's latest quarterly Bulletin.

The program was put on
a highly systematic basis in 2001, so as to lift it above the level of
anecdote. Specialised officers talk to up to 100 businesses a month. You
try to speak to a range of businesses (or, failing that, industry
associations) in each of the economy's industries. You speak to the same
people each time, asking the same questions and seeking quantification
where possible.

You stay conscious of the gaps in your industry
coverage. Ensuring you speak to businesses across the nation means
"liaison" is the main role of the Reserve's state branches. Ideally,
this should alert you to differences between the state economies.

Some
industries are dominated by few big companies, making them easier to
cover. But others - particularly the service industries - are composed
mainly of small businesses. This is much harder and it's where you may
need to fall back on industry associations.

The
Reserve uses its liaison more to determine where the economy is now -
and where particular industries are in their business cycle - than where
it's headed.

Most of the intelligence it produces ends up fitting
reasonably well with the official statistics, but in some cases it
comes in earlier than the stats.

It's a reasonable fit also with
the NAB survey of business conditions and confidence, which the Reserve
always studies carefully.

The Reserve's well-established links
with key businesses allow it to "hit the phones" at times of great
uncertainty, such as the global financial crisis. Its liaison made it
among the first to realise business was responding differently to the
downturn in demand, preferring wage freezes and cuts in hours to mass
layoffs.

Its contact with miners made it among the first to
realise the biggest hangover from the Queensland cyclone in 2011
wouldn't be farming but the surprising delay in getting the water out of
flooded coalmines.

Right now its resource contacts will help
improve its guesses about the precise timing of the probably sharp
fall-off in mining investment spending.

By now other central
banks, including the Bank of Canada and the Bank of England, also
conduct big business liaison programs, but our lot were early adopters.

Now
you're better informed about the Reserve's use of liaison you're likely
to be more conscious of the many references to its findings in the
bank's pronouncements.

The Reserve regularly reviews the accuracy
of its forecasts and publishes the sobering results. So does Treasury,
for that matter. Neither institution pretends its forecasts are much
more than educated guesses.

The central bankers haven't been able to detect that their liaison has done anything to improve the accuracy of their forecasts.

But
it would a brave - or foolhardy - person who concluded from this that
it was wasting its time. Managing the economy without major mishap is a
bit trickier than getting forecasts spot on.

Saturday, October 25, 2014

Gough Whitlam was a giant among men who changed Australia forever - and
did it in just three years. No argument. The question is whether the
benefits of his many reforms exceeded their considerable economic costs.

The
answers we've had this week have veered from one extreme to the other.
To Whitlam's legion of adoring fans - many of whom, like many members of
his ministry, have never managed to generate much understanding or
interest in economics - any economic issues at the time aren't worth
remembering.

To his bitter, unforgiving critics - led by former
Treasury secretary John Stone - his changes were of dubious benefit, in
no way making up for the economic chaos he brought down upon us.

The truth is somewhere in the middle.

To
his many social reforms must be added a few of lasting economic
benefit: diplomatic and trading relations with China, the Trade
Practices Act with its first serious attack on anti-competitive business
practices and - the one so many forget - the Industries Assistance
Commission, whose efforts over many years led eventually to the end of
protection against imports, removed by the next Labor government.

Not
all of his many social reforms have survived. The Hawke-Keating
government removed remaining vestiges of his non-means-tested age
pension and ended the failed experiment with free university education,
which did little to raise the proportion of poor kids going to
university, but cost a fortune and delivered a windfall to the middle
class at the expense of many workers.

The best modern assessment
of the Big Man's economic performance comes in the chapter by John
O'Mahony, of Deloitte Access Economics, in The Whitlam Legacy, edited by
Troy Bramston.

O'Mahony's review of the economic statistics tells
part of the story: "The years of the Whitlam government saw the
economic growth rate halve, unemployment double and inflation triple".

But
that conceals a wild ride. By mid-1975, inflation hit 17.6 per cent and
wage rises hit 32.9 per cent. The economy boomed in 1973 and the first
half of '74, but then suffered a severe recession.

From an
economic perspective, Whitlam did two main things. He hugely increased
government spending - and, hence, the size of government - by an amazing
6 percentage points of gross domestic product in just three years.

Some
have assumed this led to huge budget deficits. It didn't. Most of the
increased spending was covered by massive bracket creep as prices and
wages exploded.

Many of Whitlam's new spending programs should
have come under his predecessors and would have happened eventually.
Some can be defended as adding to the economy's human capital and
productive infrastructure, others were no more than a recognition that
our private affluence needn't be accompanied by public squalor.

From
this distance it's hard to believe that in 1972 large parts of our
capital cities were unsewered. That's the kind of backwardness Whitlam
inherited.

The Whitlam government's second key economic action was
to pile on top of high inflation huge additional costs to employers
through equal pay, a fourth week of annual leave, a 17.5 per cent annual
leave loading and much else.

Clyde Cameron, Whitlam's minister
for labour, simply refused to accept that the cost of labour could
possibly influence employers' decisions about how much labour they used.

From
today's perspective, there's nothing radical about equal pay or four
weeks' leave. But to do it all so quickly and in such an inflationary
environment was disastrous.

When the inevitable happened and
Treasury and the Reserve Bank jammed on the brakes and precipitated a
recession, Labor's rabble of a 27-person cabinet concluded the
econocrats had stabbed them in the back, panicked and began reflating
like mad.

What Labor's True Believers don't want to accept is that
the inexperience, impatience and indiscipline with which the Whitlam
government changed Australia forever, and for the better, cost a lot of
ordinary workers their jobs. Many would have spent months, even a year
or more without employment.

But what the Whitlam haters forget is
that Labor had the misfortune to inherit government just as all the
developed economies were about to cross a fault-line dividing the
postwar Golden Age of automatic growth and full employment from today's
world of always high unemployment and obsession with economic
stabilisation.

Thirty years of simple Keynesian policies and
unceasing intervention in markets were about to bring to the developed
world the previously impossible problem of "stagflation" - simultaneous
high inflation and high unemployment - that no economist knew how to
fix, not even the omniscient and infallible John Stone.

It was 30
years in the making, but it was precipitated by the Americans' use of
inflation to pay for the Vietnam war, the consequent breakdown of the
postwar Bretton Woods system of fixed exchange rates, the worldwide
rural commodities boom and the first OPEC oil shock, which worsened both
inflation and unemployment.

The developed world was plunged into
dysfunction. The economics profession took years to figure out what had
gone wrong and what policies would restore stability. Money supply
targeting was tried and abandoned.

The innocents in the Whitlam
government had no idea what had hit them; that all the rules of the
economic game had changed. The point is that any government would have
emerged from the 1970s with a bad economic record.

Malcolm Fraser had no
idea the rules had changed, either. His economic record over the
following seven years was equally unimpressive.

It took the rest
of the developed world about a decade to get back to low inflation and
lower unemployment. It took us about two decades. I blame the Whitlam
government's inexperience, impatience and indiscipline for a fair bit of
that extra decade.

My strongest feeling is that when the
electorate leaves one side of politics in the wilderness for 23 years
it's asking for trouble. It's Time to give the others a turn after no
more than a decade.

Wednesday, October 22, 2014

Oh dear, what an embarrassment. Thank heavens so few journalists
noticed. Last month, one of the federal government's official
bean-counters, the Australian Institute of Health and Welfare, issued
its report on total spending on health in 2012-13. It didn't exactly fit with what the government has been telling us.

As
you recall, Health Minister Peter Dutton got an early start this year,
warning that health spending was growing "unsustainably". (Blame it all
on Gough Whitlam, whose supposedly too-expensive Medibank Malcolm Fraser
dismantled, only to have Bob Hawke restore it as Medicare.)

The
report of the Commission of Audit soon confirmed that health was
prominent among the various classes of government spending growing - and
projected to continue growing - "unsustainably".

Something would have to be done.

In
the budget, we found out what the something was. A new "co-payment" of
$7 a pop on visits to the GP and on each test the GP orders. The general
co-payment on prescriptions to rise by $5 to $42.70 each.

And the
previous government's funding agreement with the states to be torn up,
with grants for public hospitals to rise only in line with inflation and
population growth.

Sorry, but it was all growing "unsustainably".

So
how unsustainable was growth in 2012-13? Total spending on health goods and
services was $147 billion, up a frightening 1.5 per cent on the
previous year, after allowing for inflation.

This was the lowest growth
since the institute's records began in the mid-1980s, and less than a
third of the average annual growth in the past decade.

Allow for
growth in the population, and average annual health spending of $6430
per person was actually down a touch in real terms.

It gets better (or worse if you've been one of the panic merchants).

That
$147 billion is the combined spending on health by the federal
government, state governments, private health funds and other insurers,
plus you and me in direct, out-of-pocket payments on co-payments and
such like.

So, total spending may not have grown much, but the
federal government's share of the tab rose faster than the rest, right?
Err ... no. The opposite, actually.

The feds' health spending in 2012-13 actually fell by 2.4 per cent in real terms. The states' spending rose by 1.5 per cent, but that left the combined government spend falling by 0.9 per cent.

So
it was actually the private sector (including you and me) that
accounted for more than all of the overall increase in spending. This is a big
problem for the government?

By my reckoning, out-of-pocket
payments by individuals rose by 6.9 per cent in real terms. The pollies
seem to have been doing a good job of shunting health costs off onto us
even before the latest onslaught.

So, all very embarrassing for
the three-word-slogan brigade. Or would have been had the government's
spin doctors not had the media off chasing foreign will-o-the-wisps at
the time. Easily diverted, the media.

But let's be reasonable
about this. One year of surprisingly weak growth in total health
spending - and falling federal spending - doesn't prove there isn't
longer-term problem.

Government health spending has grown pretty
strongly in previous years, and the latest year's moderation may be the
product of one-off factors rather than the start of a new moderate
trend.

Actually, the real fall in federal spending seems to be
largely the product of savings measures taken by the previous
government, particularly its tightening of rules for the private health
insurance rebate - which the Coalition fought so hard to stop happening.

Even
so, when you look at the trend of spending in recent years revealed by
the institute's figures, it does suggest that health spending may not
grow as strongly in coming years as we've long been told to expect.

The
spectre of ever more rapid growth in public spending on healthcare - to
the point where health spending comes to dominate the federal budget -
is one the federal Treasury has been warning of in each of its three
"intergenerational reports" since 2002.

The state treasury
versions of this exercise portray health spending positively overrunning
state budgets, crowding out all other spending.

Federal Treasury has
explained its dramatic projections in terms of the ageing of the
population, developments in medical technology that invariably are much
more expensive than the technology they replace, and the public's
insatiable demand for immediate access to whatever advances medical
science has come up with.

But Treasury's figures are essentially
mechanical projections of past growth trends over the coming 40 years,
meaning just a small reduction in the assumed annual rate of growth can
make a big difference.

The institute's latest figures show the
federal government's real spending on health grew at an annual rate of
4.8 per cent over the five years to 2007-08, but by just 4.1 per cent
over the five years to 2012-13.

Perhaps more significantly, they
show that whereas the prices of health goods and services rose faster
than the prices of all domestic goods and services by 0.7 per cent a
year during the first five-year period, during the second period they
rose by 0.2 per cent a year more slowly than other prices.

In other words, the long-feared problem of "excess health inflation" seems to be going away.

It will be interesting to see Treasury's latest prognostications in next year's intergenerational report.

Monday, October 20, 2014

It's still too soon to tell whether Tony Abbott's government is
pro-market or pro-business, but so far the evidence for the latter
stacks higher than that for the former.

The difference turns on
whether the pollies want markets where effective competition ensures
benefits to consumers are maximised and excessive profits minimised, or
markets where government intervenes to limit competition - often under
the cover of claiming to be protecting jobs - and makes life easier for
favoured businesses.

Will we see more rent-seeking or less under Abbott, more of what The Economist calls "crony capitalism"?

Will
firms or industries with rival interests do better from government
regulation if they're more generous donors to party coffers?

Abbott
and his ministers' intemperate attacks on the Australian National
University for its decision to "divest" itself of a few million mining
company shares for environmental or ethical reasons are a worrying sign.

Investors
shouldn't enjoy freedom to choose where they invest, regardless of
their reasons? ANU is different from the rest of us even though its
investment funds come largely from private donations and bequests? This
from a government keen to complete the de facto privatisation of
universities?

What is ANU's offence? Bringing ethical
considerations into investment? Or sounding like it believes climate
change is real and we should be doing something real about it?

Abbott
attacked ANU's decision as "stupid" and believes "coal is good for
humanity, coal is good for prosperity, coal is an essential part of our
economic future".

If ever there was an industry whose early
decline could be confidently predicted - as it is being by hard-headed
investors and bankers the world over - it's steaming coal.

Yet Abbott seems keen to change the rules of the formerly supposed bipartisan renewable energy target in ways that, by breaking long-standing
commitments to the renewables industry, would cost it billions and
blight the future of its employees, all to provide the government's coal
and electricity industry mates with temporary relief from the
inevitable.

The biggest problem with governments "picking winners"
is that they quickly regress to picking losers, helping industries
against which technology and other forces have shifted to resist the
market's pressure for change that would - almost invariably - make
consumers and the economy better off.

The proposals of the recent
draft report of Professor Ian Harper's competition policy review could
do much to strengthen the market's ability to deliver benefits to
consumers and roll back decades of accumulated rent-seeking and crony
capitalism.

The enthusiasm with which the Abbott government takes
up those proposals will tell us much about its choice between being pro
market forces or pro certain generous business donors to party funds.

A
particular area where sound competitive principles have been secondary
to special pleading from various interests is the regulation of
intellectual property, such as patents, copyright, trademarks and plant
breeder rights. Harper says our intellectual property regime is a
priority for review.

IP isn't God-given, it's a government
intervention in the market to limit competition with owners of the
patents and so forth for a limited period. It's a response to market
failure where the "public goods" characteristics of IP would otherwise
generate too little monetary incentive for people to come up with the
new knowledge and ideas that benefit us all.

In other words, it's a
delicate trade-off between government-granted monopolies to encourage
innovation, and competition to keep prices and excess profits down.

This
makes it ripe for rent-seeking: pressuring politicians to extend the
monopoly periods retrospectively (despite the lack of public benefit),
to allow loopholes that permit phoney "ever-greening" of drug patents
that would otherwise expire, to limit poor countries' access to
life-saving drugs at realistic prices and to ignore blatant gaming of IP
laws by two-bit operators that have never created anything.

Most
of these excesses are at their worst in the United States with its
easily bought legislature. The information revolution has made IP one of
America's chief export earners. And the free-trade preaching Yanks have
made advancing the interest of their IP exporters their chief priority
in trade negotiations such as the present Trans Pacific Partnership
deal.

As always, we have a tendency to give the Yanks whatever
they want. Trouble is, as Harper points out, Australia is and always
will be (and should be, given our comparative advantage in world trade) a
net importer of intellectual property.

Abbott has a further
temptation to be less than vigilant in pursuing Team Australia's best
interests: his chief media cheerleader, News Corp, happens to be the
twin brother of a primary beneficiary of the Yanks' efforts to advance
the interests of their IP exporters, 21st Century Fox.

Saturday, October 18, 2014

Economists may be bad at forecasting - even at foreseeing something as
momentous as the global financial crisis - but that doesn't stop them
arguing about events long after the rest of us have moved on.

That's
good. Economists need to be sure they understand why disasters occurred
so we can avoid repeating mistakes. They need to check the usefulness of
their various models and whether they need modifying.

One thing
that causes these debates to go for so long is that economics -
particularly academic economics - is based more on theories than
evidence. Some theories clash, so empirical evidence ought to be used to
determine which hold water.

But economists aren't true
scientists. They pick the rival theories they like best and become more
attached to them as they get older. They will try to talk their way
around evidence that seems to contradict the predictions of their model.

This
leaves plenty of room for ideology, for individuals to pick those
theories that fit more easily with their political philosophy.

There's
been much mythologising of our experience with the GFC. Many punters'
memory is that we thought there'd be a bad recession, the Rudd
government spent a lot of money, but no recession materialised so the
money was obviously wasted.

This isn't logical. You have to
consider what economists call "the counterfactual": what would have
happened had Kevin Rudd not spent all that money? Maybe it was the
spending that averted the recession.

One Australian newspaper has
worked assiduously to inculcate the memory that pretty much all Rudd's
"fiscal stimulus" spending was wasteful. It went for months reporting
every complaint against the school-building program, while ignoring the
great majority of schools saying they didn't have a problem, then
misrepresented the inquiry findings that the degree of waste was small.

What
got the economy growing again so soon after the big contraction in
gross domestic product in the December quarter of 2008, we were told,
was the return of the resources boom as China's demand for our
commodities ballooned. (This ignores that China's economy was hit for
six by the GFC, but bounced back after it applied massive fiscal
stimulus.)

To bolster the line it was pushing, the paper did much
to publicise the views of Professor Tony Makin, of Griffith University.
Makin adheres to a minority school of thought among macro-economists
that fiscal stimulus never works. He repeated his long-held views when
assessing Rudd's efforts.

Early last month, the Minerals Council
published a monograph it had commissioned from Makin on Australia's
declining competitiveness. Guess what? All the subsequent events have
confirmed the wisdom of his earlier forebodings.

Makin used "the
classic textbook macro-economic model" to argue that, even during
recessions, fiscal policy is ineffective in adding to economic growth in
an open economy with a floating exchange rate because it "crowds out"
net exports (exports minus imports).

Borrowing to cover the extra government spending
tends to push up domestic interest rates, which attracts foreign
capital inflow. This, in turn, pushes up the exchange rate. Then the
higher dollar reduces the price competitiveness of our export and
import-competing industries, thus increasing imports and reducing
exports. Any increase in domestic demand is thus offset by reduced net
external demand.

Next Makin examined the national accounts showing
a strong rebound in growth in the March quarter of 2009 (thus silencing
the two-quarters-of-negative-growth brigade) and found the turnaround
was explained not by increased domestic spending but by an improvement
in net exports.

There you go: proof positive that his long-held
views were spot on. He attacked the claim that the fiscal stimulus saved
200,000 jobs, saying "this assertion is based on spurious Treasury
modelling of the long-run relationship between GDP and employment". He
criticised Treasury's estimates using dubious Keynesian "multipliers" of
the addition to GDP caused by the fiscal stimulus.

Treasury
quickly released a response to Makin's criticism. His theoretical
argument was based on the Mundell-Fleming model (from as long ago as the
early 1960s), which assumes unilateral fiscal action, a high degree of
openness to trade and perfect mobility of financial capital between
countries. (It could have added the assumption that the central bank
controls the supply of money rather than the level of short-term
interest rates, as ours has long done.)

In reality, all the major
economies applied fiscal stimulus in concert, trade accounts for much
less of our GDP than it does for most developed countries, and the
turmoil of the GFC meant capital mobility was far from perfect at the
time (I'd say all the time).

As for his empirical checking,
Makin's use of the national accounts failed to consider the
counterfactual. It's likely imports fell in that March quarter not so
much because the dollar fell heavily (and didn't shoot back up for about
a year, once commodity prices had reversed and were on their way to new
heights) as because the fear unleashed by the GFC prompted people to
postpone planned purchases of imported items. If so, their spending
would also have fallen, offsetting to boost from net exports.

Makin's
claim that Treasury used multiplier estimates that were long-term
rather than short-term is wrong. The whole idea of the stimulus was to
boost spending (and confidence) quickly to counter the collapse in
confidence. Since the spending measures were always intended to be
temporary (and were, despite the mythology) it was always known that the
effect on GDP growth would be negative before long.

The short-term
multipliers Treasury used were based on the conservative end of the
range of estimates calculated for our economy by the International
Monetary Fund and the Organisation for Economic Co-operation and
Development.

Makin is entitled to his opinions, but he's in a
small minority among economists, even the academics. The two
international agencies were full of praise for our fiscal stimulus and
in no doubt about its effectiveness.

Wednesday, October 15, 2014

The older I get the more sceptical I become. Goes with being a journo, I
guess. I've become ever-more aware that no one and nothing is perfect.
Not political leaders, not parties, not any -isms, not even motherhood.

Take
competition. Economists portray it as the magic answer to almost
everything, but the more I see of it, the more conscious I become of its
drawbacks and limitations.

Which is not to say I don't believe in it.
Far from it. We could use a lot more competition than we've got. But
only in the right places and for the right reasons.

The recent
draft report of the review of competition policy, chaired by emeritus
professor Ian Harper, argues that we need to step up the degree of
competition in the economy if we're to cope with three big sets of
challenges and opportunities that we face: the rise of Asia, our ageing
population and the advent of disruptive digital technologies.

Dead right - up to a point.

We
need more competition in the economy because it's what keeps the
capitalist system working in the interests of the populace, not the
capitalists. But that doesn't mean it makes obvious sense to take areas
of our lives that have been outside the realm of the market and turn
them over to the capitalists.

Economics is about efficient
materialism; making sure the natural, man-made and human resources
available to us are used in ways that yield maximum satisfaction of our
material wants. It argues that economies based on private ownership and
freely operating markets - "capitalist" economies - are the most
efficient.

What's to stop the capitalists using markets to exploit
us and further aggrandise themselves? Competition. Competition between
themselves, but also between us (the consumers) and them (the
producers).

Get this: the ideology of conventional economics holds
that the chief beneficiaries of market economies should be, and will
be, the consumers, not the capitalists.

Market economies are seen
as almost a con trick on capitalists: they scheme away trying to
maximise their profits at our expense, but the system always defeats
them, shifting the benefits to consumers (in the form of better products
and lower prices) and leaving the capitalists with profits no higher
than is necessary to keep them in the game.

What it is that
performs this miracle? Competition. It's not nearly as fanciful as it
sounds. Since the industrial revolution, the history of capitalism is
the history of capitalists latching on to one new technology after
another, hoping for the killing that never materialises.

Take the
latest, digital technology and its effect on my industry, news. Who's
losing? The formerly mighty producers of the soon to be superseded
newspaper technology, including many of their journalists and other
workers. Who's winning? People wanting access to as much news as
possible as cheaply as possible.

For good measure, the cost of
advertising - reflected in the prices of most things we buy - is now a
fraction of what it was. Tough luck for producers, good luck for
consumers. Competition at work.

But, amazing though this process
is, it's far from perfect. Competition doesn't work as well in practice
as it does in theory, for many reasons. A big one is "information
asymmetry" - producers know far more about products than consumers do.
Another is the presence of economies of scale, which has led to most
markets being dominated by a handful of big companies.

Perhaps
most pernicious, however, is the success of some producers in persuading
governments to protect them from the full rigours of competition. Some
industry lobbies are particularly powerful, and the ever-rising cost of
the election arms race has made the two big parties susceptible to the
viewpoints of generous donors.

The report produced by Harper, a
former economics professor, emphasises that competitive pressure needs
to be enhanced for the ultimate benefit of consumers. With so many big
companies enjoying so much power in their markets, we need laws against
anti-competitive practices. He proposes refinements to make these laws
more effective.

He points to industries where governments need to
reform laws that limit competition at the expense of customers: retail
pharmacies, taxis and coastal shipping. He advocates "cost-reflective
road pricing" and an end to restrictions on "parallel imports" of books,
recordings, software and so on (fear not, the internet's doing it for
us) and local zoning laws that implicitly favour incumbents (Woolies and
Coles, for instance) at the expense of new entrants (Aldi and Costco).

But,
predictably, there's little acknowledgement that competition has costs
as well as benefits. It's assumed that if some choice is good, more must
be better. And competition-caused efficiency outweighs all social
considerations.

So the report advocates liberalising liquor
licensing, and deregulation of shopping hours on all but three holy days
a year (the holiest being Anzac Day), without any serious consideration
of the effects on sobriety and crime in the first case or family life,
relationships and what I like to call re-creation in the second.

Similarly,
it sees nothing but benefit in maximising choice and competition
between schools, and wants much more outsourcing of the delivery of
government-funded services to profit-motivated providers.

The
inquiry we need is one to check how well previous experiments in mixing
government funding with the profit motive - in childcare, for instance,
or training courses for international students - have worked in
practice. We need more evaluation and fewer happy economist assumptions.

Monday, October 13, 2014

With the Reserve Bank worried by fast-rising house prices, but the
dollar coming down and the unemployment rate now said to be steady, can a
rise in the official interest rate be far off? Yes it can.

On the
face of it, last week's revised jobs figures have clarified the picture
of how the economy is travelling. The national accounts for the March
and June quarters show the economy growing at about its trend rate of 3
per cent over the previous year, which says unemployment should be
steady.

And now the jobs figures are telling us the unemployment
rate has been much steadier than we were previously told, at about 6 per
cent.

If economic growth is back up at trend, we need only a
little more acceleration to get unemployment falling. The Reserve is
clearly uncomfortable about keeping interest rates at 50-year lows while
rapidly rising house prices tempt an already heavily indebted household
sector to add to its debt.

So, surely it's itching to remind us
that rates can go up as well as down and, in the process, let some air
out of any possible house-price bubble.

Well, in its dreams,
perhaps, but not in life. Even if hindsight confirms the latest reading
that the economy grew at about trend in 2013-14, the Reserve knows it
can't last. Its central forecast of growth averaging just 2.5 per cent
in the present financial year is looking safer, maybe even a little
high.

The sad fact is that a host of factors are pointing to
slower rather than faster growth in 2014-15, implying a resumption of
slowly rising unemployment and no scope for even just one upward click
in interest rates.

The biggest likely downer is the long-feared
sharp fall in mining investment spending. To this you can add weak
growth consumer spending, held back by weak growth in employment and
unusually low wage rises.

Now add the point made by Saul Eslake,
of Bank of America Merrill Lynch, that real income is growing a lot more
slowly than production, thanks to mining commodity prices that have
been falling since 2011.

Weak growth in income eventually leads to
weaker growth in production, which, in turn, is the chief driver of
employment. With the Chinese and European economies' prospects looking
so poor, it's easy to see our export prices falling even faster than the
authorities are forecasting.

Real gross domestic income actually fell in the June quarter, and Eslake sees it falling again in the September quarter.

Apart
from the recovery in home building, pretty much the only plus factor
going for the economy is the recent fall in the dollar, bringing relief
to manufacturers, tourist operators and others.

But measured on
the trade-weighted index, the Aussie is back down only to where it was
in February, and since then export prices have fallen further, implying
the exchange rate is still higher - and thus more contractionary - than
it should be.

In other words, the usually strong correlation
between the dollar and our terms of trade has yet to be restored. Why
hasn't it been in evidence? Because our exchange rate is a relative
price, affected not just by what's happening in Oz but also by what's
happening in the economy of the country whose currency we're comparing
ours with.

The Aussie has stayed too high relative to the
greenback not because our interest rates have been too high relative to
US rates, as some imagine, but because one of the chief effects of all
the Americans' "quantitative easing" has been to push their exchange
rate down.

As the US economy strengthens and the end of
quantitative easing draws near - and, after that, rises in their
official interest rate loom - the greenback has begun going back up. The
prospects of it going up a lot further in coming months are good.

That's
something to look forward to. But our exchange rate would have to fall a
long way before it caused the Reserve to reconsider its judgment that
"the most prudent course is likely to be a period of stability in
interest rates".

But that still leaves the real risk of low rates fostering further rises in house prices, particularly in Sydney and Melbourne.

What
to do? Resort to a tightening of "macro-prudential" direct controls
over lending for housing. The restrictions may be announced soon, be
aimed at lending for investment and even limited to borrowers in the two
cities.

But though they'd come at the urging of the Reserve,
they'd be imposed by the outfit that now has that power, the Australian
Prudential Regulation Authority.

Saturday, October 11, 2014

I could attempt to explain to you why the Bureau of Statistics is having
such embarrassing trouble with its monthly estimate of employment, but I
won't bother. It's horribly complicated and at a level of statistical
intricacy no normal person needs to worry about.

What this week's
labour force figures now tell us is that, though the rate of
unemployment has been slowly drifting up since mid-2011 - when it was 5
per cent - it seems to have steadied this year and, using the smoothed
figures, has stayed stuck at 6 per cent for the past three months.

This
is reasonably consistent with what we know about other labour-market
indicators, such as job advertisements and vacancies, claims for
unemployment benefits and employers' answers to questions about hiring
in the National Australia Bank's survey of business confidence.

It
also fits roughly with what the national accounts have been telling us
about the strength of growth in the economy. We know that when the
economy is growing at its trend rate of about 3 per cent a year, this
should be sufficient to hold the rate of unemployment steady.

The
accounts told us real gross domestic product grew by 3.4 per cent over
the year to March, and by 3.1 per cent over the year to June.

But
now let me tell you something that, while a bit technical, is much more
worth knowing than the gruesome details of the bureau's problem with the
labour force survey.

One of our smartest business
economists, Saul Eslake, of Bank of America Merrill Lynch, has reminded
us that GDP is only one of various summary indicators of overall
economic activity provided by the national accounts. And the economy's
peculiar circumstances over the past decade and for some years to come
mean GDP is not the least misleading of the various measures.

Eslake
says real GDP measures the volume (quantity) of goods and services
produced within a country's borders during a particular period.
(Actually, it doesn't include the many goods and services produced
within households, which never change hands in a market.)

To
estimate real GDP the bureau takes the nominal, dollar value of the
goods and services produced, then "deflates" this figure by the prices
of those goods and services relative to what those prices were in the
base period.

We commonly take the value of the goods and services
we produce during a period to be equivalent to the nation's income
during that period. This easy assumption works for most developed
economies most of the time.

But Eslake reminds us that "for an
economy like Australia's, the prices of whose exports are much more
volatile than those of other 'advanced' economies, abstracting from
swings in the prices of exports (and imports) obscures a significant
source of fluctuations in real incomes".

We've experienced a
series of sharp swings in our "terms of trade" - export prices relative
to import prices - over the past decade of the resources boom, which was
interrupted by the global financial crisis in 2008-09. For the past three years, of course, mining commodity prices have been falling.

Trouble is, real GDP doesn't capture the effects of these swings. So
the values of our production and our income have parted company, as
they do every time our terms of trade change significantly. An
improvement in our terms of trade causes our income to grow faster than
our production, whereas a deterioration has the opposite effect.

This
matters because of the chicken-and-egg relationship between production
and income: we use the income we earn from our part in the production
process to buy things and thus induce more production.

So if our real income slows or falls, soon enough this dampens our production.

However,
the national accounts include a measure of overall economic activity
that does capture the effects of movements in our terms of trade: real
gross domestic income, GDI. It grew a lot faster than real GDP for most
of the time between 2002 and 2011, but since then has grown much more
slowly than real GDP (a big reason for our slowly rising unemployment).

Next
Eslake says that as the resources boom moves into its third and final
phase - with mining investment winding down and exports ramping up -
real GDP growth will be an even less useful guide to what's happening to
domestic income and employment.

This is because maybe 80 per cent
of the income generated by resources exports will be paid to the
foreigners who own most of our mining companies and who financed most of the
new investment.

It's also because the depreciation of Australia's
greatly enlarged stock of capital equipment and structures as a result
of all the mining investment spending will now absorb a greater share of
our gross income.

(A separate issue Eslake doesn't mention is
that the highly capital-intensive nature of mining means the increased
production of mineral exports will create far fewer jobs than you'd
normally expect.)

If you've ever wondered about the difference
between gross national product and gross domestic product it's that the
former excludes all the income earned on Australian production that's
owed to the foreign suppliers of our debt and equity financial capital,
making it a more appropriate measure for us given our huge foreign debt
and foreign investment in our companies.

If you've ever wondered
what the "gross" in GDP, GNP, GNI etc means, it's short for "before
allowing for the depreciation of our stock of physical capital".

So
gross national income (GNI) is a better measure than gross domestic
income (GDI), and net national disposable income (NNDI) is a better
measure than GNI.

Which, by the way, explains why real NNDI is
used as the base for all the further non-national-accounts-based
modifications included in Fairfax Media's attempt to calculate a broader
measure of economic welfare, the Fairfax-Lateral Economics wellbeing
index, released each quarter soon after the publication of GDP.

Wednesday, October 8, 2014

The good thing about holidays is getting time to read books. I' ll look
at all the museos, oratorios, cappellas and duomos in Italy provided I
can go back to my book when day is done. On this trip one book I read
was Moral Tribes, by Joshua Greene, a young professor of psychology at
Harvard.

One of the hottest areas of psychology these days is moral
psychology - the science of moral cognition - which seeks to explain
why we have moral sentiments and what use they are to us. It' s pretty
coldly scientific and evolutionary, which may be disconcerting to
readers of a religious disposition.

According to Greene and his
confreres - another leading thinker in the area is Jonathan Haight,
author of The Righteous Mind, which I' ve written about before - humans
are fairly selfish individuals, but we are also highly social animals who
like to be part of groups.

Groups, however, require co-operative
behaviour, so we evolved moral attitudes to enable us to get along
together in groups.

Biologists (and economists) have long stressed the
importance of competition between us - survival of the fittest and all
that - but it s not hard to see that humans' domination of the planet
arises from our unmatched ability to co-operate with each other to
overcome problems.

So humans are about competition and
co-operation. Economists have schooled us to think of markets as all
about competition - between sellers, between buyers and between buyers
and sellers - but psychologists see markets as a prime example of human
co-operation.

Co-operation through markets allows us to use
specialisation - I produce what I' m good at, you do the same and we use
the medium of money to exchange the things we ve produced - to increase
our combined efficiency in production, leaving us all better off.

Studies
have shown that people' s performance in well-known psychology games
giving them a choice between selfish or altruistic responses can differ
markedly between cultures. Turns out that people from cultures with more
developed market systems tend to be less selfish and more co-operative.

So
to these scientists, morality is a set of psychological adaptations
that allow otherwise selfish individuals to reap the benefits of
co-operation within groups.

But why do we want to co-operate within groups? So our group can compete more effectively against other groups.

" Our
moral machinery evolved to strike a biologically advantageous balance
between selfishness (Me) and within-group co-operation (Us), without
concern for people who are more likely to be competitors than allies
(Them), " Greene says. This moral machinery includes our capacities
for empathy, vengefulness, honour, guilt, embarrassment and righteous
indignation, he adds.

The fact is that each of us belongs to a
whole host of groups: our family, neighbourhood, workplace, occupation,
nationality, ethnicity, religious affiliation, sporting interest,
political party and more.

The groups we belong to are the tribes
we belong to. We feel a great loyalty to our groups, and greatly favour
their interests over those of rival groups. This group selfishness and
tendency to see the world as Us versus Them is tribalism.

So, much
of the conflict we see around us - both within our country and, as
we' ve become more conscious of in recent days, between countries and the
groups within them - arises from tribalism.

Much of the conflict
between tribes is simple self-interest - I favour my interests ahead of
yours, and see them much more clearly than I see yours - but there are
also genuine differences in values and disagreements about the proper
terms of co-operation. One major source of disagreement in political
life is between individual and collective responsibility.

Obviously,
tribally based morality gets us only so far. What Greene seeks is a
"meta-morality" , which can help reduce conflict between tribes rather
than just within them. To this end he reaches back to an old idea now
out of favour with philosophers: utilitarianism.

(This is of
relevance to economists because, though they 've spent the past 80 years
trying to play it down, utilitarianism forms part of the bedrock on
which the conventional economic model is built.)

According to
Greene, utilitarianism answers two basic questions: what really matters
and who really matters. What matters most is the quality of our
experience. Economists call this " utility" and the rest of us call it
"happiness" .

Who matters most is all of us, equally - otherwise known
as the Golden Rule.

Thus Greene summarises utilitarianism as
" happiness is what matters and everyone' s happiness counts the same.
This doesn 't mean that everyone gets to be equally happy, but it does
means than no one' s happiness is inherently more valuable than anyone
else' s ."

He claims this meta-morality involves a moral system
that can acknowledge moral trade-offs and adjudicate among them, and can
do so in a way that makes sense to members of all tribes.

It s a
nice thought. Somehow I think it will be a while before we measure up to
that ideal. But it s always good to have a vision of what we should be
aiming for and how we can move towards it.

Monday, October 6, 2014

The failings of economists - the bum forecasts and less-than-wise advice
they give us about the choices we face - can usually be traced back to
the limitations of the basic model that tends to dominate the way they
think, the neo-classical model.

The thinking of economists began to
ossify in the second half of the 19th century, at a time when the
science of psychology was in its infancy. The model was thus
consolidated at a time when our understanding of human behaviour was
quite primitive.

Unfortunately, the past century of progress in
psychology has revealed just how far astray are many of the economic
model's assumptions about how humans tick. Although a minority of
economists - "behavioural economists" - have sought to incorporate these
findings into their thinking, the majority have ploughed on regardless.
It keeps the maths simpler.

The model is often criticised, not
least by me, for its key assumption that we are always "rational" -
carefully calculating and self-interested - and never instinctive or
emotional in the decisions we make, but there's another assumption
that's equally unrealistic and likely to lead to wrong predictions about
how we'll behave.

It's that consumers and businesses always act
as isolated individuals in making their decisions, uninfluenced by the
decisions those around them are making, except to the extent that the
combined behaviour of others affects the prices the individual faces. In
other words, the model's "unit of analysis" is the individual - the
"representative consumer" or "representative firm".

In truth,
humans are highly social animals and our behaviour is hugely influenced
by those around us. We evolved to live in small groups, which has left
us with a powerful - if often unconscious - motivation to fit in with
the group and avoid being ostracised.

We feel most comfortable when
we're doing what everyone else is doing; we feel distinctly
uncomfortable when we're doing the opposite to everyone else. We feel
great loyalty to the groups we belong to, and rivalry and suspicion
towards groups we don't belong to.

This means humans - "economic
agents" as economists say - are prone to herd behaviour. At the most
innocuous level, this makes us heavily influenced by fashion. We like to
wear what others are wearing, read what others are reading and watch
the movies and TV shows that others are watching.

It's remarkable
that the business world could be so conscious of the need to accommodate
and, indeed, exploit our susceptibility to fashion while the economists
seek to analyse our behaviour using a model that assumes it away.

More
significantly, our tendency to herd behaviour affects the behaviour of
markets - particularly financial markets - in ways that, though we've
seen it happen many times before, almost invariably catch economists
unawares.

It's our propensity for "group-think" that does most to
explain booms and busts in the sharemarket, but also the upswings and
downswings in the economy. We swing from overly optimistic to overly
pessimistic, then back again, and we tend to all do it together.

A
separate aspect of the model's exclusive focus on the individual is its
overemphasis on competition and underemphasis on co-operation. It's
actually the human animal's unmatched ability to co-operate in solving
problems that has given our species its mastery over the planet.

Human
behaviour is composed of competition and co-operation. We form
co-operative groups so as to enhance their ability to compete with other
groups. But the economists' model captures only one dimension of the
process.

The classic example of group co-operation to facilitate
competition is, of course, that bedrock of modern economies, the
company. Companies - often very large, multinational companies -
dominate our economy, but the model tells us nothing about what goes on
inside them and economists don't have much to tell us about how the
existence of big companies affects the behaviour of markets.

The
final and perhaps most important twist that the economic model's focus on
individuals imposes on economists' thinking is an inbuilt bias against
intervention in markets by co-operation at its highest level,
government.

The market of individual consumers and individual
(tiny) firms is assumed to be self-sufficient and self-correcting, thus
making intervention by government something alien and more likely to
make things worse than better.

The reality, of course, is that
governments not only need to "hold the ring" - provide the protection of
property rights and legal enforcement of contracts - they also need to
impose rules that protect the market, and the rest of us, from the
consequences of its own herd-driven excesses.

Saturday, October 4, 2014

So, you're a regular reader of the business pages and you reckon you're
smarter than the average bear when it comes to financial matters. Well,
here are some common "biases" to which people fall victim when making
decisions about financial products. See if you can put hand on heart and
swear you've never made any of these mistakes. If you can, you're a lot
smarter than me.

Have you ever overspent on your credit card, or
paid off less of it than you know you should? And if you pass that one,
try this one: are you confident you're saving enough to ensure your
retirement is as comfortable as you'd like it to be?

If you fall
short on any of those, you've been affect by what psychologists call
"present bias" and behavioural economists call "time-inconsistent
preferences" (so in the competition to make your discipline sound
smarter than it is, the economists win).

People often succumb to
the urge for immediate gratification, thinking too little about the
problems this will create for them down the track. It's natural -
economists would say "rational" - to value the present more highly than
the future. But if you go too far in that direction and end up
regretting the choices you made, you've overvalued the present and
undervalued the future, making your preferences inconsistent over time.

Most
of us have a self-control problem in some field or other. People who
are overconfident about their ability to control themselves in the
future - to, say, manage heavy repayments - will make their lives more
of a pain than they need to be.

Those who are more realistic often
use "commitment devices" to impose self-control on themselves. The most
extreme example is to cut up your credit card. Compulsory
superannuation contributions for employees are a kind of
government-imposed commitment device to help us save for retirement -
which may be why so few people object.

Businesses exploit our
self-control problems by, say, designing a gym subscription that seems
cheap, but only if we keep using it for the length of the contract. Or
by starting a credit card or home loan with a low interest rate (known
in the trade as a "teaser" rate) but then jumping to an overly high
rate.

Have you ever delayed moving to a better bank account, or
putting some of your savings in a term deposit paying a higher interest
rate? The experts call this "procrastination" (now that's a surprise)
and class it as a version of present bias.

Examples are legion:
deciding to cancel something but not getting around to it, not checking
to see if the accounts and the loans and phone contracts you have are
still the best available, or not putting much work into searching for
the best deal in the first place.

This, too, leaves you open to
exploitation by businesses. Some offer a "free trial" while knowing few
people will cancel the deal when the paying period begins. Even
requiring cancellation by post exploits our inertia.

Have you ever
driven a hard bargain to buy a new car, but then gone overboard buying
extras like rust-proofing, window-tinting or an improved security
system? Have you ever bought a new TV or computer, then been sold
extended warranty insurance?

Have you ever hung on to shares now
worth less than you paid for them, hoping they will come good and you
won't have to accept you made a bad decision to buy them?

If so, you've fallen victim to the biases of "reference dependence" in the first case and "loss aversion" in the second.

It's
virtually impossible to look at something and decide what you think
about it without consciously or unconsciously comparing it with
something else. When buying a car, we compare and contrast all the ones
we could buy. Failing that, we compare the one we're thinking of buying
with our old one. If we don't have an old car to compare with, we
compare having one with going by bus.

Comparisons are almost
unavoidable. But we're so dependent on having something else to compare
with - use as a point of reference - that if a sensible comparison isn't
available we'll use one that makes no sense at all.

An old
experiment asks people to estimate how many African countries are
members of the United Nations. Most people have no idea. But if, before
or while asking the question I mention 60, many people will seize on
that number. Do I reckon the number of countries is more or less than
60? How much more, or how much less? That's an easier question to
answer.

This way of making decisions is known as "anchor and
adjust" and all of us use it all the time, consciously and
unconsciously. Trouble is, 60 was a number plucked from the air.
Experiments show that if you mention 100 rather than 60 before asking
the question you get higher answers.

Point is that our reference
dependence makes us easy meat for clever salespeople. We go overboard
buying extras for our new car because they all seem so cheap relative to
the huge sum we've just forked out to buy the car.

Likewise with
extended warranties, which are notoriously overpriced for what little
you get back. Anyone wanting to buy "peace of mind" is usually
overcharged.

It's an empirical fact that most of us hate making losses much more than we love making gains. By about two to one, they say.

This
explains why we do silly things like hanging on to dud shares we should
sell - and then should put the proceeds into something with better
prospects of gain.

These examples come from a report on
behavioural economics prepared by Britain's new Financial Conduct
Authority, which has been charged with finding ways to prevent
businesses taking advantage of our lack of rational thinking. Good idea.